On December 19, 2023, the Reserve Bank of India (“RBI”) issued a circular ‘Investments in Alternative Investment Funds (AIFs)’ (“Circular”) stipulating certain conditions with respect to Regulated Entities (such as banks, non-banking financial companies) investing in alternative investment funds (“AIF”). Regulated Entities, AIFs as well as various companies raised certain concerns on the impact and implication of the Circular. In light of the same, the RBI on March 27, 2024, issued a circular providing certain clarifications and relaxations (“New Circular”). The key provisions of the Circular as well as the New Circular are summarized below.

1. Restrictions on making investments in an AIF

As per the Circular, Regulated Entities cannot make investments in any scheme of AIFs which has downstream investments either directly or indirectly in a debtor company of the Regulated Entity (i.e., any company to which the Regulated Entity currently has or previously had a loan or investment exposure anytime during the preceding 12 (twelve) months).

Pursuant to the New Circular, it has been clarified that downstream investments would exclude investments in equity shares of the debtor company of the Regulated Entity. Accordingly, a Regulated Entity can make investments in an AIF even if the AIF invests in the equity shares of a debtor of the Regulated Entity. However, it has also been clarified that downstream investment would include all other investments including investment in hybrid instruments. Therefore, the above relaxation will not apply in such cases. Considering that structuring investments through hybrid equity instruments is not uncommon, a large number of investments will continue to fall within the ambit of the Circular.

2. Liquidation of investments

As per the Circular, if an AIF scheme, in which the Regulated Entity is already an investor, makes a downstream investment in any debtor company of the Regulated Company, then the Regulated Entity is required to liquidate its investment in such AIF scheme within 30 (thirty) days from the date of such downstream investment by the AIF scheme. If Regulated Entities have already invested into AIF schemes having downstream investment in the former’s debtor companies as on the date of the Circular, the 30 (thirty) day period for liquidation is counted from the date of the issuance of the Circular and the Regulated Entities would be required to advise the AIFs suitably in the matter.

As mentioned above, the New Circular provides that downstream investments shall not include investments in equity shares of the debtor company of the Regulated Entity. Apart from the said relaxation, no other no relaxation has been provided for this condition.

3. Requirement of provisioning

As per the Circular, in case Regulated Entities are not able to liquidate their investments within the time limit prescribed above, they are required to make 100% (one hundred percent) provisions on such investments.

The New Circular provides that provisioning shall only be required to the extent of investment by the Regulated Entity in the AIF scheme which has further invested in the debtor company of the Regulated Entity, and not on the entire investment of the Regulated Entity in the AIF scheme.

4. Deduction from capital funds

In addition to the above, the Circular provides that investments by Regulated Entities in the subordinated units of any AIF scheme with a ‘priority distribution model’ shall be subject to full deduction from the Regulated Entity’s capital funds.

Pursuant to the New Circular, the said condition shall only be applicable in cases where the AIF does not have any downstream investment in a debtor company of the Regulated Entity. If the Regulated Entity has investment in the subordinated units of the AIF scheme, which also has downstream exposure to the debtor company, then the Regulated Entity shall be required to comply with provisions of paragraph 2 of the Circular pertaining to restrictions on investment in AIF by Regulated Entities, liquidation of investments, and requirement of provisioning. Further, with regards to proposed deduction, the New Circular states that such deduction from capital shall take place equally from both Tier 1 and Tier 2 capital. Additionally, reference to investment in subordinated units of AIF scheme shall include all forms of subordinated exposures, including investment in the nature of sponsor units.

5. It has also been clarified that investments by Regulated Entities in AIFs through intermediaries such as fund of funds or mutual funds would not be subject to the conditions and restrictions stipulated in the Circular.

Please find a copy of the Circular here, and a copy of the New Circular here.

This update has been contributed by Aastha, Adity Chaudhury (Partners), Anushkaa Shekhar, Arth Singhal and Tanu Kankariya (Associates).

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